CURRENCY MATTERS

Written on the 15 July 2010

The last three years have seen an extraordinary period across all global financial markets. Not least affected were the currency markets which experienced historical levels of volatility. During this time, the Australian dollar rose to near parity levels against the US dollar, then fell precipitously to nearly 60 cents before recovering strongly. Ben Kilmartin is the former global head of currency clients at JP Morgan Asset Management. Kilmartin now manages the BK Currency Fund which makes long term investments in the currency markets. He gazes into the currency crystal ball.

MANY businesses in Australia have been impacted in the roller-coaster currency ride.

Australia has a very open economy with a large proportion of business activity dependent on foreign trade. Importers and exporters are particularly sensitive to exchange rate changes. Exporters benefit when the Australian dollar is weak. Importers conversely enjoy a strong Australian dollar. There is little doubt that businesses will have suffered greatly and profited handsomely at different times during the currency gyrations.

Those businesses that use currency hedging will have smoothed out some of the exchange rate fluctuations on their bottom line in the short term, but what is the long-term impact of sustained currency weakness or strength?

Global economy

The global economy has since recovered from the first global recession since World War II. But concerns over the level of public debt in many developed economies have raised the spectre of a double dipped recession in some regions. Given that the Australian economy is largely dependent on international trade and global economic growth, the Australian dollar has experienced significant volatility in recent months in the uncertainty.

The outlook for the global economy is mixed. The sovereign debt crisis in Europe is likely to weigh on the region’s economy for some time to come. The United States does seem to be making a recovery, however, unemployment remains stubbornly high and the stimulus package used to stimulate the economy has led to record levels of debt.

Australian Outlook

In contrast to other developed economies, Australia has comparatively low levels of government debt. Although the Federal Government is currently running a budget deficit, Australia is ranked 106 out of 128 countries when measured by the level of government debt relative to the economy, according to the Central Intelligence Agency. In addition Australia is seemingly in the early stages of a long resources boom driven by economic growth in emerging markets like China and India.

Assuming that China and other developing countries continue on their growth trajectories, the Australian mining boom should continue well into the future and underpin the economy.

The implication in this scenario is that the Australian dollar should remain strong. The mining boom offers a significant investment opportunity for a broad range of foreign institutions and should result in substantial foreign capital investment in Australia. The resources sector should also deliver considerable foreign currency revenues to the Australian economy for many years to come.

Impact on Gold Coast businesses

If the Australian dollar remains strong, then this will have a detrimental impact on other export orientated industries. On the Gold Coast, the economy is largely dependent on tourism. A strong Australian dollar means Australia is more expensive as a tourist destination for foreigners.

Additionally, Australian domestic tourists destined for the Gold Coast for their holidays may otherwise be drawn to foreign destinations. For example, a holiday to the UK may now be up to 30 per cent cheaper than two years ago just from the fall in the value of the pound. Combined with increased competition from the airline industry and cheaper international airfares, the Australian tourism industry faces some challenges ahead.

Is the Aussie dollar overvalued?

There is a view that the Australian dollar is overvalued at current levels, having ranged between 50 cents and parity since the mid 80s. But if you look at comparative price levels of developed economies, it does not necessarily look high, particularly when compared to Japan and parts of Europe. This implies that the Australian dollar has generally been undervalued historically on a comparative price basis and the currency has now risen to more normal levels.

In conclusion, the Australian dollar looks set to be volatile in the forthcoming period due to uncertainty in the global economic recovery. But if the European debt crisis is contained without serious impact on global economic growth prospects, then the Australian economy looks set to remain strong, and with it, the Australian dollar.